Out of the Frying Pan

One of the more interesting questions about the Housing Bubble Era of 2001-2008 actually has to do with what happened in the years before its rise. Why didn’t the LTCM failure, the “Asian” Financial Crisis (which certainly seemed like a big crisis in Russia at the time), the collapse of the NASDAQ bubble, and the revelation of massive accounting fraud all during the 1997-2000 period prompt some kind of more meaningful action. At the time, I can recall that there was a lot of talk in the air of the need for reform.

John Quiggin recalls:

Neither of these things happened. Advocates of the efficient markets hypothesis, in general, simply ignored the dotcom fiasco, and went on as if nothing had happened. The accounting scandals at Enron and other companies produced the Sarbanes-Oxley Act, which sought to reform corporate governance. But the Act was limited and largely ineffectual. Within a year or two, the conventional wisdom of the financial markets was that Sarbanes-Oxley was an over-reaction to isolated cases of fraud, and that a new push for deregulation was needed.

Financial institutions could disregard the failures of the dotcom bubble because of the (seemingly successful) operation of the Greenspan put. Rather than let the financial sector suffer the consequences of the bursting bubble, Greenspan relaxed monetary policy and inflated a whole new bubble, this time in housing.

This is a somewhat strange problem. Whatever you think of Greenspan’s overall legacy—and I think it’s appropriate to take a very dyspeptic view of his fiscal policy interventions in 1999-2001 and of his interest rate policy in 2004—I think it’s a bit hard to regret that he acted swiftly and decisively to keep the world out of a major recession at the turn of the millennium. The millennial recession was not a fun time for the aversely affected, but relatively few people were aversely affected because it was relatively short and shallow. Letting things fall apart would have led to millions of additional unemployed people, state budget crises, cutbacks in critical social services, etc., etc., etc.

But it really does seem that the success of these operations was taken as a reason to avoid any serious systematic reform. And you can feel the same kind of thing happening today. It’s disturbing.